News from DNB Markets

(10.06.2011)
Neither Bank of England nor ECB chose to hike at yesterday's monetary policy meetings. Trichet lived up to the market's expectations by signaling a hike in July, but the euro has nevertheless weakened. Norwegian core inflation is expected to fall back again in May.

By Kjersti Haugland, Senior Economist at DNB Markets

Bank of England and the ECB left their key policy rates unchanged at yesterday's meetings.

ECB-governor Trichet delivered what most people had expected: the message that inflation risks remains to the upside, warranting "strong vigilance" from the central bank. Historically, the latter formulation has signalled a hike at the next meeting. Consequently we are strengthened in our belief that the refi rate will be raised by 25 basis points to 1.50% in July.

ECB has revised its inflation projection for 2011 upwards, to between 2.5% and 2.7%. The estimate for 2012 was unchanged though. Trichet repeated that the key policy rate should be used for one purpose only: to deliver price stability and thereby anchor inflation expectations.

However: the extraordinary liquidity measures, featuring full-allotments to a fixed rate, would be maintained for as long as it is necessary, and as a minimum throughout the next three months. When a journalist confronted Trichet with the matter of a possible restructuring of Greek government debt, Trichet answered that the ECB remains strictly opposed to any arrangements that are not completely voluntary from the investors' side. This is in conflict with the proposal from German Finance Minister Schäuble in a letter to his euro colleagues previously this week, where he wanted to force a seven year extension of the maturity of the obligations.

Despite signals about a July hike: the euro weakened in the wake of the ECB meeting. EURUSD has weakened by 0.9% since yesterday morning, and is at the moment traded slightly below 1.45. The US trade deficit shrank surprisingly and markedly in April, and contributed to a welcome glimpse of optimism after a wave of negative US news lately. The shrinkage, from USD 49.7 bn in March to 43.7 bn in April, was due to a combination of solid export growth and falling imports. The latter is mainly a result of reduced imports of cars and car parts from Japan after the catastrophe struck in end-March, and will hence be temporary.

Statistic Norway, central bank governor Olsen's former employer, stuck to its view of a strong, consumption-led upturn, when the bureau's new estimates for the development in the Norwegian economy was published yesterday. With prospects of increasing pressure in the Norwegian economy going forward, Olsen undoubtedly wants to continue hiking. ECB's monetary policy will mean a lot to Norges Bank's leeway however.

About 30% of Norwegian consumers' consumption basket consists of imported consumer goods. The prices of these goods have been falling for an extended period, mainly because of a stronger NOK. If Norway proceeds significantly faster than its trading partners in the tightening cycle, the attractiveness of the NOK will increase (other factors being equal), and likely lead to a further krone appreciation and a larger negative drag from imported inflation.

At the moment, core inflation is far below Norges Bank's 2.5% inflation target. We expect today's core inflation (CPI ATE) release to show a 1.0% y/y growth in May. Last month's number was a solid surprise, both to the market and to Norges Bank. CPI ATE rose by 1.3% y/y, while consensus was 0.8%. The deviation from expectations could in its entirety be explained by an extraordinarily large rise in the price of airline fares, especially for fares abroad. This is probably a temporary phenomenon, due to a very late Easter vacation this year. Excluding transports, the inflation picture was on the weak side of our expectations.

China's export growth slowed in May (19.4% y/y in May, down from 29.9% in April), due to the soft patch in international demand. Imports were stronger than expected though (28.4% y/y, up from 21.8% in April), which shows that domestic demand is remaining strong despite different kinds of tightening measures from the Chinese authorities lately.